Save money by minimizing loan interestJan 24, 2022 02:20PM ● By Arthur Vidro
My sister-in-law recently discovered the mortgage payment she and her husband fork over each month is not reducing their mortgage debt one iota. Their mortgage payments are being applied exclusively to interest payments on the loan and the loan balance isn’t being reduced.
Fixed-rate mortgages is when the interest rate remains constant for the life of the loan. Some mortgages are variable rate, which means the interest rate will fluctuate depending on what the future cost of borrowing money becomes. Balloon-rate mortgages mean your rate is fixed until a given date, and then it skyrockets. Too many people only concern themselves with their rate at the moment, and don’t worry about rates they might be contractually bound to pay down the road.
Some mortgage lenders will let you pay down your loan balance. It’s a simple matter of making an additional payment and earmarking it specifically for the loan balance. This is best accompanied by writing “reduce loan balance” in the subject section of your check, and accompanying it with a note spelling out your intention. And then following up to make sure your instructions were carried out.
Paying down your loan balance results in your interest rate being applied subsequently to a smaller principal, which means less money is paid in interest over the life of the loan.
Some mortgages though, are drawn up in language that prohibits you from paying down your balance until after all your interest is paid off. This is to the lender’s advantage because it guarantees that the maximum amount of interest will be paid on your loan.
On a smaller scale, the same system applies to car loans.
Many dealerships make more money from the interest you pay them on a car loan than from selling you the car in the first place. That’s why dealerships try hard to make sure you take out your car loan from them, not from a third party. They’ll tell you they offer the best possible rates; sometimes that’s true, sometimes not.
I bought a new car for the first time in 1996. I purposely chose a Saturn dealership because Saturn treated all its customers alike. There was no dickering or negotiating. Each car had a single price, each optional feature had a single price, and no matter how much or how little you knew about cars, that was the price you would pay.
After a salesperson and I had settled upon a car, I was directed to another office where the chap in charge of paperwork sat. He explained the buying process until we reached the point of having to decide on a schedule of monthly car payments.
“How much would you like to pay?” he asked.
I thought for a moment, then replied, “What are the options?”
I was asking a simple enough question, I thought, but he did a double-take and leaned back.
“You know,” he said, “that’s the first time I’ve ever been asked that.”
I asked, “How do other people respond when you ask them how much they’d like to pay?”
He told me they all pretty much tell him they want to pay “as little as possible” each month.
But paying as little as possible per month means it will take you many more months (perhaps years) to pay off the car. It will extend the life of the loan and will vastly increase the amount of interest you end up paying over the loan’s lifetime.
I selected a four-year plan but paid it off in three. The plan allowed me to make additional payments as often as desired, and by doing so, I could pay off the loan earlier than contractually called for and thus reduce the amount of total interest paid on the loan.
Not all auto loans allow you to do that. After all, the lender wants as much of your money as possible—which they maximize by having you pay as little as possible each month.